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Oil Markets Balancing Much Faster Than Thought

Oil markets are only a few months away from a much closer balance as demand holds steady and supply drops off. Several reports from the three major energy entities more or less say the same thing – the supply overhang that the world has experienced over the past two years should narrow and start to close in the second half of 2016.

The International Energy Agency estimates that the world is dealing with a supply surplus of 1.3 million barrels per day (mb/d) right now, which should last through the end of the second quarter. By the third and fourth quarters, however, the surplus shrinks to just 0.2 mb/d.

For its part, OPEC largely agreed in its May Oil Market Report. But OPEC also chose to focus on the slightly longer-term, citing the massive cut in capital expenditures taken over the past two years. The industry has slashed $290 billion from 2015 and 2016 spending levels so far, with more cuts expected. The spending reductions contributed to the shockingly low level of new oil discoveries last year – the industry discovered less than 3 billion barrels of new oil reserves in 2015, the lowest level in six decades. With few new discoveries, and a rising number of projects deferred, there is a very low level of new projects in the pipeline, so to speak. In other words, oil supply and demand curves are converging towards a balance, and could even cross over at some point a few years down the line as supply fails to keep up with demand.

The forecasts are obviously just a rough benchmark, and there is a great deal of uncertainty surrounding output levels from so many oil companies and countries around the world. For example, the IEA said that Iran has defied expectations by ramping up oil production rapidly in recent months, adding 0.6 mb/d since March, hitting their highest levels since November 2011.

But, if anything, the risk of uncertainty for these projections is more likely to be on a smaller surplus. That is to say, surprise supply disruptions are a common occurrence in the oil markets, and the past few weeks are a perfect example. Canadian wildfires knocked off more than 1.2 million barrels per day of production, a disruption that will be temporary, but ultimately could last a few weeks. Nigeria has lost roughly 0.4 to 0.5 mb/d due to a handful of attacks on oil pipelines and platforms. Shell and Chevron have shut down facilities and evacuated personnel because of attacks from the Niger Delta Avengers. Venezuela has seen production decline at least 0.1 mb/d from last year, and could fall another 0.2 mb/d at least over the course of 2016. Related: Appreciating Dollar Caps Crude Rally Again

All of these supply disruptions come on top of the expected decline in output from around the world, especially high cost U.S. shale. U.S. oil production has fallen to 8.8 mb/d as of early May, taking the loss in U.S. oil production to about 900,000 barrels per day since April 2015.

On the bearish side of things, however, there are more than a few potential surprises. Saudi Arabia’s newly powerful Deputy Crown Prince Mohammed bin Salman said just ahead of the failed Doha talks in April that Saudi Arabia had the ability to ramp up oil production by 1 mb/d in the near-term, a threat that could push oil prices down.

Also, despite the supply disruptions and the solid declines in U.S. oil production, storage levels are still at record highs. The EIA reported a surprise drawdown in storage levels in its most recent weekly report, the first decline in several weeks. But at 540 million barrels, high oil storage levels will have to be worked through before oil prices can rise substantially.

However, in fits and starts, the necessary adjustment in oil supply and demand is well on its way.

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